New Mountain Finance Q3 2023 Earnings Call Transcript

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November 3, 2023

There are 7 speakers on the call.

Operator

Good morning, everyone, and welcome to the New Mountain Finance Corporation's 3rd Quarter 2023 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to John Klein, President and CEO.

Operator

Please go ahead.

Speaker 1

Thank you, and good morning, everyone. Welcome to New Mountain Finance Corporation's Q3 2023 earnings call. On the line here with me today are Steve Klinsky, Chairman of NMFC and CEO of New Mountain Capital And Laura Holson, COO and Interim CFO of NMFC. Steve is going to make some introductory remarks, But before he does, I'd like to ask Laura to make some important statements regarding today's call.

Speaker 2

Thanks, John. Good morning, everyone. Corporation and that any unauthorized broadcast in any form is strictly prohibited. Information about the audio replay of this call is available in our November earnings press release. I would also like to call your attention to the customary Safe Harbor disclosure in our press release and on Page 2 of the slide presentation regarding forward forward looking statements.

Speaker 2

Today's conference call and webcast may include forward looking statements and projections, and we ask that you refer to our most recent filings with the SEC Form Important Factors That Could Cause Actual Results TO Differ Materially From Those Statements and Projections. We do not undertake to update our forward looking statements or projections unless required to by law. To obtain copies of our latest SEC filings and to access the slide presentation that we will be referencing throughout this call, Please visit our website at www.newmountainfinance.com. At this time, I'd like to turn the call over to Steve Klinsky, NMFC's Chairman, who will give some highlights beginning on Page 5 of the slide presentation. Steve?

Speaker 3

Thanks, Laura. It's great to be able to address you all today, Both as NMFC's Chairman and as a major fellow shareholder. Adjusted net investment income For the Q3 was $0.40 per share, more than covering our $0.32 per share regular dividend That was paid in cash on September 29. Our earnings increased by $0.08 compared to Q3 of last year and $0.01 sequentially over Q2 of this year. Our net asset value per share decreased slightly to 13.06 $0.08 decline compared to last quarter, demonstrating continued stable credit performance across our portfolio.

Speaker 3

Particularly attractive in less certain economic times. New Mountain's private equity funds have never had a bankruptcy or missed an interest payment, And the firm now manages over $45,000,000,000 of assets. Similarly, as shown on Page 14 of this presentation, Since inception over 12 years ago, NMFC has experienced net gains across all of its realized credit investments With only $89,000,000 of unrealized depreciation on our books as of the end of Q3. The higher rate environment continues to be a substantial positive for our quarterly earnings. We expect to continue to significantly outperform our $0.32 per share regular dividend at current interest rates If all other factors hold constant.

Speaker 3

Given our earnings of $0.40 per share this quarter, We will make our 3rd consecutive variable supplemental dividend payment. The variable supplemental dividend for this quarter Will be $0.04 per share, which is equal to half of the amount of our Q3 quarterly earnings in excess of our regular dividend of $0.32 This additional $0.04 dividend will raise the total dividend to $0.36 per share all in for this quarter, Which is at the high end of our previous guidance. NMFC will pay these distributions on December 29 To holders of record as of December 15. The remainder of the excess earnings will remain on our balance sheet And may be paid out in the future. Our dividend of $0.36 represents an annualized current dividend yield Of just under 12%.

Speaker 3

Looking forward to Q4, in addition to our $0.32 regular dividend, We expect to generate a variable supplemental dividend of $0.03 to $0.04 per share payable in the Q1 of 2024. This incremental payout is supported by expected strong credit performance and continued elevated base rates. We believe the strength of New Mountain and of NMFC is driven by the quality of our team. New Mountain overall Now numbers 250 members and the firm has developed specialties in attractive defensive growth that is acyclical growth sectors Such as life science supplies, healthcare information technology, software infrastructure services and digital engineering. When pursuing our credit investing efforts, we utilize our extensive group of industry experts to provide unique knowledge and expertise that allows us to make very informed high conviction underwriting decisions.

Speaker 3

Over the last 9 months, we have continued to expand the quality of our overall team. Finally, we as management continue as major shareholders of NMFC. Senior management and employee share ownership has been rising over time and we now own approximately 13% of NMFC's total shares personally. With that, let me turn the call to John.

Speaker 1

Thank you, Steve. Good morning again, everyone. I would like to offer some more details on our direct lending investment strategy and track record. Starting on Page 8, we highlight our disciplined industry selection, We have successfully avoided cyclical, volatile and secularly challenged industries, which could be riskier areas to invest in today's higher rate environment. Our strategy has been consistent over our 12 plus years as a public company And it allows us to operate with confidence in any economic environment.

Speaker 1

Page 9 provides a high level snapshot of our business Since our IPO in 2011, NMFC has returned over $1,100,000,000 to shareholders Through our dividend program, generating an annualized return of approximately 10%. Our current portfolio is exposed to companies In good industries that are performing well and where our last dollar of risk is approximately 40% of the purchase price paid for the business. We lend primarily to businesses owned by financial sponsors who are sophisticated and supportive owners with significant capital Junior to the loans that we make. Turning to Page 10, the internal risk ratings of our portfolio were relatively stable quarter over quarter with approximately 93% of our portfolio rated green. Our most challenged names within the orange and red categories represent only approximately 2% of NMFC's fair value and we have de risked our book by marking our red names to 11% of face value and our orange names to 68% of face value.

Speaker 1

At these valuation levels, our weaker names do not represent material future downside risk to our book value. The updated heat map is shown in its entirety on Page 11. Given our portfolio's orientation towards defensive sectors like software, Business Services and Healthcare. We believe our assets are well positioned to continue to perform no matter how the economic landscape develops. We did have two names representing only 1% of total fair value migrate negatively this quarter.

Speaker 1

Both companies are experiencing short term operational headwinds, but we remain optimistic about the long term value proposition And prospects for a full recovery on our 1st lien positions. On the positive side, we are pleased to report the EaglePicher's 2nd lien, Which was previously a yellow name marked at $0.70 was moved to green during the quarter and subsequently repaid at par in October. Overall, as we reflect on the prospects of our yellow names, we are optimistic that we may have more positive outcomes like this one in the future. Turning to Page 12, we provide a graphical analysis of NAV changes during the quarter. Starting on the left, credit specific movements represented a $0.20 decrease in book value driven by relatively minor equity markdowns reflecting the more challenged valuation environment for midcap companies.

Speaker 1

Broad credit market movements were an $0.08 book value tailwind as credit spreads tightened during Q3 due to the modest new issue supply. And as Steve mentioned earlier, we over earned the regular and supplemental dividends by $0.04 per share, Which accrued to our book value. Combined these changes netted to an $0.08 decline in book value for the quarter. It is important to note that if we were to value all of our green rated loans at par and continue to value the balance of the portfolio at current fair value, Our book value would be $13.50 compared to our actual NAV of $1306 at 9:30. Page 13 addresses NFC's non accrual performance.

Speaker 1

On the left side of the page, we show the current state of the portfolio Where we have $3,100,000,000 of investments at fair value with $48,000,000 or 1.5 percent of the portfolio currently on non accrual. The number of companies on non accrual decreased this quarter as we moved Integro's 2nd lien back to accrual status Due to our increased conviction of a full recovery in the next 12 months. Of the names that remain on non accrual, most are from older vintages, Have been written down materially and have a good chance of exiting the portfolio in the medium term. On the right side of the page, we show our cumulative credit performance since IPO where MFC has made $9,200,000,000 of investments And achieved net gains on all realized positions of $15,000,000 This is consistent with our value proposition of preserving principal value and distributing nearly all of our net investment income through predictable quarterly dividends. On Page 14, we present NMFC's overall economic performance since IPO, showing that we have delivered consistent and compelling returns.

Speaker 1

Cumulatively, NMFC has earned $1,200,000,000 in net investment income, while generating $15,000,000 cumulative net realized gains and only $89,000,000 of net unrealized depreciation, netting to over $1,100,000,000 value created for our shareholders. Page 15 shows a stock chart detailing NMFC's equity returns since IPO. Over this period, NMFC has generated a compound annual return of approximately 10%, which represents a very strong cash flow oriented return well in excess of both the high yield index and an index of BDC peers who have been public at least as long as we have. I I will now turn the call over to our Chief Operating Officer and Interim Chief Financial Officer, Laura Holston to discuss our current portfolio construction and financial results.

Speaker 2

Thanks, John. We continue to believe the outlook for the rest of 2023 2024 in the sponsor backed direct lending market is positive. Deal flow continues to be down overall as valuation expectations reset in the world of higher base rates. There are pockets of activity in our defensive growth verticals where we have the opportunity to make loans at attractive yields while remaining very selective. Yield structures remain compelling with leverage levels meaningfully below peak levels and significant sponsor equity contributions representing the vast majority of the capital structures.

Speaker 2

We remain bullish on the medium and long term outlook for M and A Given the magnitude of dry powder for private equity and the ongoing need to return capital to LPs as well as the general maturity wall facing borrowers, We saw a bit of a flurry of deal activity post Labor Day, including some opportunistic issuance, but it continues to be episodic at the moment. Given our large portfolio of over 100 unique borrowers, we continue to see good opportunities to make incremental loans 2 existing well performing portfolio companies seeking to pursue accretive M and A. Despite lower overall deal volume, higher ratings. Ongoing market volatility continues to push borrowers toward the more certain execution of a direct lending deal. Page 17 presents an interest rate analysis that provides insight into the positive effect of increasing base rates on NMFC's earnings.

Speaker 2

As a reminder, the NMFC loan portfolio is 88% floating rate and 12% fixed rate, while our liabilities are 50% fixed rate and 50% floating rate. Moving on to Page 18. In Q3, we continued our focus on modest deleveraging towards the middle of our 1 to 1.25 times debt to equity range. As a result, outside of some modest DDTL draws, we actually experienced net repayment activity as several borrowers repaid due to refinancings or M and A. I'd highlight that 2 of the repayments were 2nd lien positions whereby strong performance enabled both companies to take out the 2nd lien with incremental 1st lien.

Speaker 2

Given the high base rate environment, impact of minor deleveraging has not impeded our ability to significantly out earn our regular dividends. As I discussed in the market overview, We continue to see compelling opportunities and post quarter end have received a few additional repayments that should provide some available capital for deployment into our highest conviction deals. In addition to the $10,800,000 EaglePicher repayment that John mentioned, We also received a post quarter end repayment of our $67,500,000 position in Finet, a dermatology practice management business. Turning to Page 19, we show that our asset mix is consistent with prior quarters, where about 2 thirds of our investments, inclusive of 1st lien, SLPs and net lease are senior in nature. Approximately 8% of the portfolio is comprised of our equity positions, the largest of which are shown on the right side of the page.

Speaker 2

As mentioned in prior quarters, we hope to monetize certain of these equity positions in the medium term and rotate those dollars into cash yielding assets. Our net lease portfolio, while only 4% of the portfolio, continues to be a strong performer, and with creditworthy tenants in our core defensive growth verticals. We like the longer duration nature of the asset class, annual rent escalators as well as the downside protection associated with owning the physical real estate. We've generated $41,000,000 of realized gains to date in the strategy and a weighted average cash yield of approximately 11%. Page 20 shows the current portfolio at a glance.

Speaker 2

We own 70 operationally essential and geographically diversified properties, including manufacturing facilities, pharmaceutical manufacturing and packaging facilities and warehouses that are leased to 13 tenants. We have no office or retail exposure. Page 21 shows that the average yield of NMFC's portfolio has increased from 11.6 Generally speaking, spreads remain attractive and support our net investment income targets. Page 22 highlights the scale and credit trends of our underlying borrowers. As you can see, the weighted average EBITDA of our borrowers has increased over the last several quarters to $147,000,000 While we first and foremost concentrate on how an opportunity maps against our defensive growth criteria and internal New Mountain Knowledge.

Speaker 2

We believe that larger borrowers tend to be marginally safer, all else equal. We also show the relevant leverage and interest coverage stats across the portfolio. Portfolio company leverage has been consistent over the last several quarters. Loan to values continue to be quite compelling and the current portfolio has an average loan to value of 42%. From an interest coverage perspective, we've continued to see modest compression as base rates rise.

Speaker 2

The weighted average interest coverage on the portfolio declined slightly And note that we've seen sponsors continue to proactively support company liquidity and continued M and A activity. This is a great indication that our portfolio consists of companies that are performing well and that are able to attract additional investment and healthy valuations. Finally, as illustrated on Page 23, we have a diversified portfolio across 110 portfolio companies. Top 15 investments inclusive of our SLP funds and net lease account for about 42% of total fair value and represent our highest conviction names. I will now cover our financial results.

Speaker 2

For more details, Please refer to our quarterly report on Form 10 Q that was filed yesterday with the SEC. As shown on Slide 24, portfolio had approximately $3,100,000,000 in investments at fair value on September 30 and total assets of $3,300,000,000 with total liabilities of $2,000,000,000 of which total statutory debt outstanding was $1,600,000,000 excluding $300,000,000 of drawn SBA guaranteed debentures. Net asset value of $1,300,000,000 13.06 dollars per share was down slightly compared to the prior quarter. At quarter end, our statutory debt to equity ratio was 1 point 2 one times to 1 and 1.16 times net of available cash on the balance sheet, consistent with the balance sheet deleveraging I mentioned previously. On Slide 25, we show our quarterly income statement results.

Speaker 2

For the current quarter, we earned total investment income of 90 $4,100,000 a 20% increase over prior year. Total net expenses were approximately $53,700,000 18% increase over prior year. As a reminder, the investment advisor has committed to a management fee of 1.25% for if and as needed during this period to fully support the $0.32 per share regular quarterly dividend. It is important to note that the investment advisor cannot recoup fees previously waived. Our adjusted NII for the quarter was $0.40 per weighted average share, which meaningfully exceeded our Q3 regular dividend of $0.32 per share.

Speaker 2

We believe this consistency shows the stability and predictability of our investment income. Importantly, over 99% of our quarterly non cash income is generated from our green rated names. Turning to Slide 27, the red line shows the coverage of our regular dividend. This quarter, adjusted NII exceeded our Q3 regular dividend by $0.08 per share. Q4 2023, our Board of Directors has again declared a regular dividend of $0.32 per share as well as a supplemental dividend of $0.04 per share.

Speaker 2

On Slide 28, we highlight our various financing sources and diversified leverage profile. Taking into account SBA guaranteed debentures, We had $2,200,000,000 of total borrowing capacity at quarter end with $313,000,000 available on our revolving lines subject to borrowing base limitations. We have a valuable mix of fixed and floating rate debt and the 50% of fixed rate debt continues to be an earnings tailwind. As a reminder, covenants under both of our Wells Fargo and Deutsche Bank Credit Facilities Are generally tied to the operating performance of the underlying businesses that we lend to rather than the marks of our investments at any given time, which we think is particularly important during more volatile times. Finally, on Slide 29, we show our leverage maturity schedule.

Speaker 2

As we've diversified our debt issuance, we've been successful at laddering our maturities to manage liquidity. Post quarter end, we have successfully amended both of our Wells Fargo and Deutsche Bank Credit Facilities to extend maturities to 20282027, respectively. Debt matures in or after 2027. Our multiple investment grade credit ratings provide us access to various unsecured debt markets that we continue to explore to further ladder our maturities in the most cost efficient manner. With that, I would like to turn the call back over to John.

Speaker 1

Thank you, Laura. As we look out over the balance of 2023, we remain confident in the quality of our investment portfolio And believe we are on track to continue to deliver great risk adjusted returns for our shareholders. We once again thank you for your support and look forward to maintaining an open and transparent dialogue with all of our stakeholders.

Operator

We will now begin the question and answer session. On your touch and to withdraw your questions. Our first question comes from Finian O'Shea from Wells Fargo. Finian, please go ahead.

Speaker 4

Thanks and hey everyone, good morning.

Speaker 1

Good morning.

Speaker 4

How are you? Can you expand on The advisor revolver upsize post quarter, and how might that Play into the remaking of your capital structure if applicable. Thank you.

Speaker 2

Sure. Yes. So post quarter end, we upsized our management company revolver from 50 and also extended maturity, 3 years to December 27 from December 24. And it still remains a relatively small portion of our overall liability stack, but we do think it's an important signal from just The commitment from the investment advisor, but also just generally helps support liquidity. We've historically not ever drawn on this facility, But again, it's good to have is just incremental liquidity.

Speaker 2

And it was just part of, I would say, a series of things that we did on the liability side post quarter end to try to We push out maturities, which continues to be a big focus for us.

Speaker 4

Great. That's helpful. And just to Drill down a touch more, as you pointed out, you don't really use it. So does the upsize indicate that you Might use it or is it more of a show of support to for your other lending facilities that this is a sort of supplement to liquidity you might need?

Speaker 1

I view this somewhat as a show of force. I mean, we have really strong relationships with all of our key providers. And as Laura said, we extended many of those facilities just recently. And as we get bigger and as we're in an uncertain environment, why wouldn't we try to So as Laura said, we don't expect it to use it, but we just really wanted to show every avenue for liquidity and balance sheet strength that we could and the manager was more than happy to do that.

Speaker 4

Okay, great. Thank you. Just a follow-up, you touched on the fee waiver in your commentary. I know that was The last quarter events, the extension, but we've seen more BDCs are going that way to sort of the 125 base fee rate. So are your discussions leaning To keep it that way at the end of 2024?

Speaker 4

And if so, why not sort of permanentize it So people can, of course, model it with more confidence long term and give you that credit. Just any understanding this is still a private matter more or less, but just Color on how you're thinking about it would be helpful. Thank you.

Speaker 1

Sure. I think with a lot of investors, do get credit for being at 1.25. We've been there for a while. We've extended it 8 quarters. And I think it's fair to say that it is a topic of discussion, but when I think about our base management fee, I know there's been some activity on base management fees around the industry.

Speaker 1

I think we're Still top quartile when you look at the base management fee. So we do feel good about where we're at. We do have a track record of being shareholder friendly. We've been at 1.25 for a while. That said, we're always going to maintain dialogue with our advisor and our Board Just around that fee and other aspects to our management agreement.

Speaker 5

Thanks so much.

Operator

And our next question comes from Bryce Roe from B. Riley. Bryce, please go ahead.

Speaker 6

Thanks a lot. Good morning. Good morning, Bryce. Hey, John. Let's see, I wanted to maybe start on some of the origination activity and how it plays into repayment activity and how it plays into The balance sheet leverage, we talked about this last quarter, but it feels like you're taking a slightly more conservative approach in terms of balance sheet leverage.

Speaker 6

We've seen it come down for a couple of quarters In a row now, you just highlighted the repayment activity here subsequent to Q3. And So I guess the question is, do you think we'll see that trend continue in terms of balance sheet leverage kind of working lower? And then as far as the activity for the Q3, relatively muted origination activity, is that kind of work with this whole discussion around leverage or is it more just kind of a view of the macro environment and what you're seeing in terms of investment opportunities.

Speaker 2

Sure. I'm happy to cover that. So in terms of just the deleveraging and kind of where we are, So we do have we continue to have our stated range of 1x to 1.25x is where we're comfortable operating within that range From a leverage perspective, but as we tried to highlight, I think we are focused on trying to get more to the middle of that range, Because I think there had been several quarters in a row where we had been at the very high end of that range. And so just given the macro environment we're in, we thought it made sense to kind of come Down a little bit more towards the middle of the range. So that is what is reflected in our Q3 results here.

Speaker 2

I think it's obviously hard to predict. It does bounce around a little bit depending on kind of repayments that we get. But I think the repayments that we received after quarter end, I think we're comfortable redeploying those proceeds and continuing to operate kind of more in the middle of leverage range. So in terms of the Q3 originations, they definitely were more muted. As I said, that was intentional.

Speaker 2

I don't think it's necessarily reflective of the overall market as we have been continue to be active and see good opportunities in some other pockets of capital that we have. But we did want to make that conscious decision to get a little bit more conservative from a leverage profile for NMFC. But we as I said kind of in the market commentary, we do continue to see some good opportunities. It's not as fast and furious as it might have been a couple of years ago, But we are still seeing some. And so I do think we'll be able to redeploy some of those repayments that we received post quarter end and some attractive opportunities.

Speaker 6

That's good stuff. Thanks, Laura. And then one more for me. John, I think you highlighted the yellow rated name Getting repaid at par, up from a mark around $0.70 And you made the comment that There were prospects for possibly more yellow rated names following that same path. Can you maybe Speak to that in a little bit more detail.

Speaker 1

Sure. And I don't have any specific yellow As I'm looking at the list of the old names, I don't have any specific names that I know we're going to repay. But in general, I wanted to make point that just because the name is yellow doesn't mean that it can't go back to green. It doesn't mean that it's on a one way trip to red. And when we look at our yellow We do see names on that list that we do have some pretty good optimism around.

Speaker 1

They're not yet The way we want them to perform, but as I mentioned, I think there's a good chance that we could see some good outcomes. So every time a yellow gets repaid, we're very excited And particularly a yellow that we had marked at a fair value of $70,000,000 when that gets repaid at par, even though it was a small position, it does feel very good.

Speaker 6

Absolutely. It's a great outcome. All right. That's all I had. Thank you so much.

Operator

And we have a question now from Paul Johnson from KBW. Paul, you may proceed.

Speaker 5

Yes. Thanks for taking my questions this morning. I only have a few. On the mark for Edmonton, this quarter is down $0.03 or so on the slide you guys gave. What drove the mark Laura, was that just comp valuations or anything specific with the business?

Speaker 2

Yes. Edmentum, overall continues to be a good performer for us, Particularly when you think about just the history of that business. And so I would say the markdown this quarter is a little bit more consistent with just the overall M and A environment that we're in, where valuations we think have come down for some of the for some industries. And so we're just Kind of taking it down in sympathy a little bit with that just as we look to fair value all of our physicians every quarter.

Speaker 5

Got it. Thanks. And then just for the SLPs for all the joint ventures, I mean, as far as kind of future quarters ago. I know income has been obviously growing from those investments, but is this a good Around $8,600,000 or so is kind of what I have for Q3. Is that a decent run rate from what you think you'd be getting off the JVs or is there any sort of one time stuff in there that you expect it to be slightly lower?

Speaker 2

Yes, there's no massive one time items. Obviously, we've seen good benefit from the SLPs in particular, just the benefit Of the rising rate environment given all those underlying assets are floating rate. But as rates start to stabilize, it seems a little bit, I do think that's a reasonably good estimate. All the JV, SLPs and also net lease, they do move around a little bit just naturally quarter over quarter, but I think it's a relatively good indication.

Speaker 1

One thing that's been going on in the LOF JVs is Because those are 1st lien syndicated loan assets, over the course of the year, we have been able to trade out of lower spread names and buy higher spread names At similar dollar price. And that's been very helpful in driving better yields. So We feel very good about what we're doing in that fund, and we continue to see good opportunities to enhance The yield of portfolio without taking increased credit risk. So these are exciting little mini funds Within NMFC.

Speaker 5

Got it. Thanks for that. That's all the questions for me.

Operator

And this concludes our question and answer session. I'd like to turn the conference over to John Klein.

Speaker 1

Great. Well, thanks everyone for joining our Q3 earnings conference call and we look forward to speaking with you next year. Thank you.

Operator

The conference has now concluded. Thank you so much for attending today's presentation. You may now disconnect.

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New Mountain Finance Q3 2023
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